Last night, the Shanghai stock market dropped 8.5%. While there is no allegation of technical manipulation, the behavior is still irrational and therefore not sustainable. A few years ago, China wanted to create a stock market, and it encouraged the Chinese people to invest in it. Over 80% of China’s stock is held by retail investors, compared to about 20% here. Citing the impatience of investors to emulate the growing U.S. stock market, the Chinese government then encouraged margin trading. Today, the average investor has five times the margin debt as retail investors in the U.S. Naturally, the over-hyped stock market eventually began a normal self-correction. Instead of letting the market self-correct, the non-capitalist Chinese government started intervening in a ham-handed manner. For example, forbidding investors to sell their stock is insane! That makes investors, who had no interest in selling, realize they are forbidden from getting their cash or life savings. Suddenly, everybody wanted out of the market. More ham-handed measures soon followed. If the Shanghai stock market is a black hole for the rest of the world to get sucked into, the naive, non-capitalistic measures of the Chinese government spilled grease all around it. The otherwise healthy stock markets in the U.S. and Europe are in danger of being sucked into Chinese black hole.
The reason for today’s 8.5% drop in Shanghai is that the Chinese government did not announce any new measures over the weekend, even though it was expected. Instead, they announced liquidity measures for the economy as a whole, not the stock market. That is a step in the right direction. Let the bloodbath in the Shanghai stock market begin! It won’t be as bad as they fear but certainly worse than it would have been, if they had done nothing originally. Their effort to help only made the market collapse worse!
This is not an economic collapse. It is merely a market collapse, an irrational market collapse that will therefore not be sustained.